I’ve never bought gold before – but I’m buying it now

I’m 46 years old, and I’m about to invest in gold for the first time in my life.

You see, unlike most MoneyWeek writers, I’ve always been a big sceptic when it came to gold.

I’ve struggled to understand why people ascribe so much value to the metal. Apart from jewellery, it has virtually no use. Gold is only valuable because people say it’s valuable.

What’s more, I’m not keen on assets that never pay an income. And don’t get me started on the quasi-religious fervour of gold bugs.

But now I’ve changed my mind. I’m going to make a small investment in bullion. Here’s why…

Why I’ve changed my mind on gold

Before I go any further, I should acknowledge that many investors have made big profits from gold over the last 14 years. At the turn of the millennium, the gold price was just $288 an ounce; in May 2011, it reached above $1,900. So my scepticism on gold caused me to miss out on big gains.

This article said that gold analysts expect the gold price to average $1,219 per ounce this year, just below the current price of $1,243. Analysts cited a potential rise in the US dollar, and a possible oversupply of gold to support their view.

You might think that this pessimism would keep me away from gold. But the article just brought out my inner contrarian.

You see, the analysts got their predictions very wrong last year (for a change, the more cynical among you might say). They predicted that the average gold price for 2013 would be over $1,700. In reality, the gold price fell 30% over the year, and the average price ended up being $1,411. So red faces all round for the ‘experts’.

And as I thought about it some more, I began to think that the gold price is too low. For starters, the gold price is now roughly at the level that covers the ‘all-in’ cost of production, so it’s hard to see the gold price going much lower than this. And if the price did fall below $1,200, you’d expect to see a fall in gold production, which would then push the price back up.

I’ve also been told that demand for gold from central banks – especially emerging-market central banks – remains strong. It makes sense that these banks want to diversify away from the dollar.

And don’t forget, deflation is back on the agenda right now – or if not deflation, then low inflation. Now people more readily associate gold with being a hedge against rampant inflation. But if we get falling prices, or inflation stays low, then that should actually be good for gold.

After all, if you’re not getting much income from a bond, the fact that you don’t get any income from gold is not as a big a problem as it might be if real (after-inflation) bond yields were high.

The US taper is also really important here. I suspect that the current gold price assumes that the Fed is able to achieve a nice smooth taper this year. In other words, the market is still hoping that further reductions in bond purchases won’t trigger any market turbulence.

Now it’s possible that we’ll get a nice smooth taper. But given the mini-panic we’ve just had, and the one we had last May when the idea of the taper was first floated, the chance of more volatility looks high. And if we get that volatility, it’s not unreasonable to think that the gold price will move upwards.

An insurance policy that could turn a nice profit

As several MoneyWeek writers have argued, gold can provide some insurance to an investment portfolio. If you don’t believe that’s the case, just look at the gold price chart during the financial crisis. Sure, there was a small fall early on – but then gold moved firmly upwards while other assets were still in the doldrums.

Given that we may well get some market volatility this year, I quite fancy some insurance. And the fact that sentiment (ie as represented by all those analysts) has turned against this insurance policy just increases the attraction.

So at some point over the next week, I’m going to buy some physical gold via an exchange-traded fund (ETF). It’s not going to be a massive investment – no more than 5% of my portfolio – but I’m happy to take the plunge now. An insurance policy that could also deliver a decent profit sounds good to me.

What would you do if you were in Mark Carney’s shoes? Merryn Somerset Webb talks to our roundtable of experts to find out their views.

Ark

I dont buy the “insurance” excuse for buying gold, I am actually getting bored of reading it on every gold related article. what rewards an insurance of just 5% of portfolio size is going to give when 95% of that portfolio is tanking 3-8% each day?

please offer proper facts for investing in assets including gold rather than using the lazy false approach and calling it insurance.

gamesinvestor

The switch to insurance by Moneyweek mainly was a way to dampen the fact that Moneyweek got it wildly wrong by being very optimistic in gold until the commodity started to fall in the last 6-12 months or so.

If the gold price starts to rise, which I very much doubt as I’m with Warren Buffet in selecting productive assets over commodities, then Moneyweek will no doubt revert to their bullish stance and time announcements as a thing that had been forecasted all along.

Like analysts they always put price targets and recommendations after the event. Which to fair to Moneyweek is not a unique trait, in fact the whole fund management and hedge fund/analyst industry is playing the same game.

There is an old saying-
1. Those that don’t know — and:-
2. Those that don’t know that they don’t know.

More organisations, and individuals fall into the latter category or let’s face it if people really woke up then we wouldn’t have fund management and financial analysts would we?

MikeOS

The only reason the analyst got it wrong is because they still haven’t realised that the gold price (and silver for that matter) is being manipulated, it’s about time you ‘experts’ at MonwyWeek wise up and report the truth on bank manipulations.

Theilard33

‘the gold price is now roughly at the level that covers the ‘all-in’ cost of production’

Ok so what about 10yrs ago when gold was 300£, was gold so much cheaper to produce then? Have costs really kept pace with gold price increases? Did they produce at a loss then [unlikely]? Someone?

carefix

This is a very good question and one I asked myself and looked into.

The answer is of course inflation. Now check the official inflation for the US dollar and that certainly does not provide and explanation. There are two reasons for this: 1) US CPI figures are thoroughly rigged downward. 2) CPI figures represent a “basket” of commodities. The major commodity used in gold production is of course oil. With only 1 gram of gold per ton of ore (typical) it takes a great deal oil to extract the gold. If you check the oil price inflation over the same period I think you will see something like a 300-400% rise in the price of oil.

When OPEC falls apart later this year due to the departure of Saudi Arabia in the direction of China the dollar price of oil will rise very significantly. The dollar will lose its reserve currency status and overseas dollars will fly back to the USA causing hyper inflation.

Holding gold and silver as insurance is a good bet.

When the financial collapse arrives there are several possibly long term outcomes. The most likely of which is a new gold backed global reserve currency. When/if this happens then all the gold in the world equals all the wealth of the world or $41,600 per ounce. Silver may well be pegged to gold to encourage BRICS, MINTS and CAPABs into the new system.

carefix

I should perhaps have mentioned that most of the high grade ores in the world are now history and PMs content has fallen very significantly over the decades multipling the oil inflation effect.

Be warned however that when gold prices were higher three years ago the marginal gold mines were profitable. A falling price means that many are operating at a loss so the average figure of production costs is always biased upwards in a falling market until the unprofitable mines cease production. World gold production is now falling because of the weakening ore grade effect and falling prices. This does indicate the market bottom is close. My dollar price absolute bottom estimate is $1080/toz.

Theilard33

Thank you Carefix for the explanation.

‘When OPEC falls apart later this year due to the departure of Saudi Arabia in the direction of China’ – food for thought there also.

gamesinvestor

Does your bottom price $1080 (not 1000, or 950 or 1100 or 1150?) have some relevance with respect to the average cost to mine the stuff?
I assume the cost of extraction varies wildly and in accordance of the cost of the local economy where the mine is located.

Only and assessment of the costs of all mines and taking an average can make a number like $1,080 have any validity.

Then there is the currency exchange at each regional mine to be taken into account.

Tyler Durden

Inflation. That’s what the gold price ultimately reflects.

That’s a lot of inflation, wouldn’t you say?

Jonathan Tedd

It is the only token of wealth. All else are promises.

Orb

There is a realistic chance QE tapering will encourage a stronger USD which could ‘taper’ the gold price too. But the argument for deflation/low inflation is also valid.

A little research (Eric Sprott’s open letter to the WGC) indicates a serious shortage of the physical stuff – that’s why the physical stuff sells at such a large premium to the bank ‘fixed’ price; or why the US Fed are unable to return Germany’s gold or even let them see it (!!!). The gold ‘paper’ (ETFs) assets are what’s in over supply and the big sell-off of paper is what’s caused the drop in price & premium of the physical stuff.

EM central banks certainly are clamouring for the physical stuff (again, easily revealed with a little research) and as much of the gold is produced by EM’s, the US$1,200/ounce production cost benchmark is rubbish. The wages in those countries don’t go up as their currencies fall, so the cost of production is likely to stay the same or even fall. Also, different operations have different cost structures – those who’s costs are too high are shut down.

In recent years and further spurred on by unprecedented levels of QE, many EM’s have endured inflation rates significantly higher than those in more developed countries, and that’s what’s driven the production costs up from the ‘old $300 benchmark’ (Hmmm… a benchmark that shifts constantly!).

If you are going to buy gold through an ETF, make sure you buy Physical Gold ETFs (they’re available in £ or $).

I think a lot of ‘experts’ refer to it as ‘insurance’ to save face if they get it wrong – Ark has a valid argument!

Oh dear – where to begin. If you wish to buy physical, then get some coins/bars and ensure you have physical delivery. If you buy an ETF you’re buying paper gold that probably corresponds to a fiction or a multiple allocation. Just ask the Bundesbank who asked the FED to return their gold only to be told it’s not there and it will take 7 years to scrape together. Why would you think ETFs are managed any more honestly than the FED’s gold holdings on behalf of foreign governments ?

John M

So true. The fact that the major ETFs short their customers does suggest they are less than honest.
Physical is best, but if you don’t like the buy/sell margin try BullionVault.com.

FR-75

Holding actual physical gold is the only true ‘insurance’, though not much of an investment over the last year. ETFs are NOT physical gold as they are often described, as all paper contracts can be subject to dubious accounting. When central banks are reported to be up to this trick too, physical gold is the only option. I don’t think the fact that most people put their money into paper contracts which can be printed like money is unrelated to the volitility in price, they’re no better than a fiat currency. Of course the other solid tangible investment which can produce a good yield is property, where most of my money is right now and doing very well too.

bernieW

Not a bad idea, but you mentioned that central banks are buying gold. So instead of purchasing ETF (which is paper gold or a receipt of gold), why not do like the central banks and take possession of gold instead?

This is similar to Germany. They no longer wanted their receipt of gold, but tried to take possession. Look what happened to them. They were told that they could get it all by 2020. Make more sense to take physical.

Very easy to do. You can purchase online with reputable resellers. You’ll be buying like China, which is buying at a discount ($1,250 ozt) and taking immediate possession.

If you do this, I recommend buying in 1oz increments. Much easier to move when you’re ready to sell. Gold eagles are great and easy to verify. Buy and hold.

Inquisitor

What about British sovereigns? They’re CGT exempt.

Is owning physical a good way to get some exposure to gold, though? What about sites like GoldMoney which offer storage services? Personally I want to build up a small portfolio of gold coins and some silver, and beyond that look to gold mining companies, and perhaps ETFs that are based on palladium.

Tyler Durden

I’d have a few sovereigns, but alas CGT can be removed at any time so you’ll just have exchanged more fiat for less gold.

CaptainPeacock

The ONLY time to buy gold is when Dominic Frisby announces hes still shorting Gold when it hits $1100/oz…now that will be the contrarian play of the decade…

Pinkers Post

The precious metal appears to be in meltdown. After an amazing bull run lasting 12 years, 2013 has seen the first negative return: Trading at around the $1,700 an ounce mark in January gold has slumped to just over $1,200, which represents a 30pc fall. This is the biggest yearly drop since 1981. So what does the future hold? The sentiment is overwhelmingly negative and, for once, Pinkers does not take a contrarian view. In fact, Pinkers believes most analysts are still too optimistic with their forecasts ranging from $1,090 to $1,200 average for 2014. In the first half of the year, gold will probably test the major support level of $900-950. This should represent a good entry point. Even a drop to $750 is not inconceivable. However, we should see consolidation in the second half, especially with Eurozone troubles reemerging and higher inflation in the US and UK. Pinkers believes gold will end 2014 around the level where it is now: $1,200. The shiny metal doesn’t need polishing: It is and always will be a ‘safe haven’ asset and widely held as an insurance policy. Physical demand, especially from India and China, will remain robust at current and lower levels but it will not be enough to make up for ETF outflows.

pinkerspost.com

gamesinvestor

I recommend Moneyweek remove this phrase, “Here’s why…”” from all future articles because it’s so intensely annoying.

Boris MacDonut

Ed,
The production price of Gold is hoverring just below $1,000 an ounce, not $1230. It may not go much below the production price, but has another $250 of fat to cull yet.

charlesdb

Buyer beware. No one knows how much Gold there really is. I’m amazed at you Ed. How can you buy a paper promise, as a hedge against Armageddon. At least buy the physical stuff. As we all know, the Gold price is being manipulated, the Germans can’t get hold of their property. The whole market in Gold is suspect.
As for insurance, what’s the Gold insurance for? You can’t eat it, you can’t drink it. Please tell me. I suspect that in the worst situation, when people discover that paper money is a confidence trick, barter of consumer goods will represent the means of exchange. And when you make your trip to the Bullion Vaults in London, New York, Zurich or Singapore, will the Gold be there for you? Or when you place your selling order for 5% of your wealth, will it be worth the price of a pint, by the time the money is cleared by the bank?

Chris Mc

Your first mistake tells me you don’t really understand gold, and for that reason I suggest you NOT buy gold. You believe you are going to buy some physical gold via an ETF. No, what you’ll have is a piece of paper, or digital equivalent, that says you are invested in gold. But that’s not gold, my friend. That’s a piece of paper with the word gold written on it. Until you understand the difference, you need to say far away from gold. I suggest you have a lot of study ahead of you.

Paul Saunders

I’ll stand up here and get scalped with you then Mr. Bowsher as I too recently went for an EDF (albeit for slightly different logic and reasoning) in gold and if it all turns into an “upside down one-of-them” we’ll go and find a park bench somewhere and share a can of Special Brew.

In my humble little inconsequential opinion people tend to overthink when it comes to gold, delivering arguments embroided the nth degree of catalysts that could send the whole Jenga tower (which is essentially what it is) tumbling down. You could probably paste most of the above arguments onto any modern day commodity with the right wording and make it stick but I’m taking a punt on gold for the sheer fact that I think it will surpass expectation in 2014.

If we’re talking insurance policies for the day when the tinfoil-hatted conspiracists get their wish and a glass full of diamonds couldn’t buy you a glass of clean water…and a piece of paper that says you are entitled to a share of gold couldn’t even buy you a ticket to so much as watch someone drink that clean water then my insurance policy is a cyanide pill and a shotgun; but until then I expect gold (whether it be ingots directly under you pillow or EDF’s) to be a pretty reliable – let’s say “counterbalance” – to my portfolio.

But I’ll keep that afore mentioned can of Special Brew in the fridge as an interim insurance policy!

Paul Saunders

Let’s change EDF to ETF. I’m worse than my Nan when it comes to acronym’s.

Earthcitizen

You got it wrong the last 10 years, what makes you think you’ll get it right the next ten or even one year?

Also note that gold is not just used for jewellery, it is also used in the electronics industry – which is partly why old gadgets are valuable.